Tuesday, July 26, 2016

Helicopter money, Canadian-style

Proponents of helicopter money have been getting a lot of press lately, but I don't really get what all the excitement is about. I live in Canada, and no nation is closer to implementing helicopter money than mine. But if I work through the basic steps involved in implementing Canadian helicopter money drops, I'm underwhelmed. As far as I can tell, deploying loonie-filled CH-147 Chinooks just doesn't do anything that other government tools don't already achieve.

Helicopter money means using the nation's central bank to fund government spending. If a government wants to spend money, it typically auctions bills and bonds to the public and uses the money to fund programs, all the while paying interest on the debt it has issued. Cue the helicopter money advocates: why not have a central bank create money from scratch and gift it to the government for spending? This certainly seems to be a more stimulative approach than regular debt-funded government spending. The added bonus is that the government gets to provide extra services to people without having to pay interest on bonds.

As I said earlier, Canada is the closest nation to implementing helicopter money. This is because the Bank of Canada is permitted to credit the government's account with newly printed money by direct purchases of Federal government bonds at government debt auctions. Canada is unique in this regard; the U.S., Europe, U.K., Japan and most other central banks have set up a fence between the nation's central bank and its executive branch that prevent the latter from financing the former. Central banks can acquire government debt, but they can only do so by buying from the private sector in the second hand market for bonds, i.e. *after* the public has first acquired government debt. This means that central bank can't create new money for the government; they can only create new money for the public, specifically banks.

Ok, so what—the Bank of Canada has no fence. While it can provide new money directly to the government, this money is free, right? After all, in order to get its hands on the funds the government still has to provide a bond to the Bank of Canada and pay interest on that bond.

But this ignores the fact that the Bank of Canada is owned by the Federal government and therefore pays all its profits to the government in the form of dividends. Thus any interest that the Federal government pays to the Bank is simply returned to the government. So the lack of a fence between the two institutions really does mean that the Bank of Canada can gift the Federal government with free money. The Bank buys new government bonds at government bond auctions, creates fresh money for the government, and re-gifts all interest it receives back to the government.

Not only does Canada lack a fence between central bank and government, but it has been making extensive use of this feature for the last five years. In 2011, the government announced a measure called the Prudential Liquidity Management Plan (PLMP), the goal of which was to increase Federal government cash reserves by an amount sufficient to cover at least one month of net projected cash flows, or around $35 billion. The Bank of Canada was to directly supply around $20 billion of this amount.

To understand how it went about this, consider that the Bank usually buys around 15% of each government bond auction. It does so in order to maintain the size its existing portfolio of government bonds. After all, bonds are always maturing and need to be 'rolled over' if the funds are to stay invested. By raising the proportion of new Government of Canada bonds that it directly purchases at government securities auctions from 15% to 20%, the Bank of Canada's rate of purchases began to exceed the rate at which bonds matured, thus leading to a steadily growing balance in the Government's account at the Bank of Canada. That's right; cue helicopter money.

The arrow on the following chart illustrates what the 5% increase in participation did to the liability side of the Bank of Canada's balance sheet:

Note how the Federal government's deposits (in red) have grown quite considerably as a result of the PLMP. By the way, if you are interested in more details on the PLMP, I've blogged more fully about it here and here.

Canada hasn't fully gone down the path to helicopter money. To qualify as helicopter money, the funds must not only be created but also be spent. While the Bank of Canada has loaded up the helicopters, the Federal government has not yet allowed any of the $20 billion to be rained down on Canadians. That is understandable since the PLMP was always supposed to be a rainy day fund.

But let's say it did deploy the helicopters. Imagine that next month Justin Trudeau, Canada's new Prime Minister, decides to spend the $20 billion in PLMP funds held at the BoC by mailing a $1000 check to every adult Canadian. Would anything out of the ordinary happen?

The heli drops complete, Canadians will deposit these checks in the banking system, either saving the funds or spending the funds. Whatever the case, the $20 billion that had previously been held in the government's account at the Bank of Canada does not disappear. It flows out of the government's account at the Bank of Canada and into the accounts that private banks maintain with the central bank. In the chart above, the entire red area would be replaced by a large jump in the green area.

The Bank of Canada pays interest to depositors at a rate that is quite close to the rate that the Federal government pays on treasury bills. Interest payments made to banks reduce the Bank of Canada's profits, which means that the dividend flowing to the Federal government is much smaller than if the helicopter drop had not been deployed.

In the end, the government ends up in the same position as it would have if it had funded its mailing of cheques with traditional bond financing. Consider the traditional way of doing things. Trudeau issues $20 billion worth of T-bills to the market at 0.5%, paying interest of around $100 million yearly. Canadians all get nice fat checks. If Trudeau instead routes his efforts through the Bank of Canada, it is the Bank that ends up paying $100 million in interest each year to private banks given a deposit rate of 0.5%. This in turn reduces government revenues by $100 million because interest costs reduce the size of the dividend that the Bank of Canada is able to pay. Either way—traditional financing or helicopter money—we get to the same ending point; Canadians get $20 billion to spend and the Trudeau government faces a cost of $100 million.

So there seems to be no difference between Justin Trudeau providing cheques to Canadian via helicopters or the regular bond-financed route. Why then are so many people quite keen on helicopter money? I'm not sure, but it could be that the advocates already know that helicopter money isn't special. Instead, helicopter money is just a way to get increased government spending without calling it government spending. Add a veneer of central bankishness to anything and it becomes sterile and boring, effectively removing any political charge that new spending brings with it.

Or maybe not, I could be missing some good reasons for why helicopter money is a truly unique tool. Feel free to correct me in the comments section, although please illustrate using Canada as your example; it's always easiest to work off of real world data.

48 comments:

Immediacy. It would put ngdp targeting directly in their control, ignoring corrections, lags, noise. No excuses. More bang for the buck, operating on income rather than debt, when at the zero bound. Allows a trade off between more debt at lower rates and less debt at higher rates, if debt is not issued, reducing debt anxiety. Not a necessity, but increased flexibility.

It adds an additional lag if they have to wait for the fiscal authority to respond though the change in debt flow is concurrent. It does but it is largely indirect. Lower rates will affect new borrowing immediately and debt service after an adjustment lag, expectations as public and private adjust to them over time, but is dependent on others response. Even distributing income is dependent on people spending it, but that is much more direct and less problematic than the decision to take on more debt or alter spending in response to it. Expectations can even be perversely affected, confirming the economy is worse and worsening and suggesting even more will have to be done, so the initial response can be counter to the intent.

" Central banks can acquire government debt, but they can only do so by buying from the private sector in the second hand market for bonds, i.e. *after* the public has first acquired government debt. This means that central bank can't create new money for the government; they can only create new money for the public, specifically banks."

I can't see any importance to the distinction. You write an IOU, sell it to Tom, who sells it to me. I'm still lending to you.

Well if you imagine that the public goes on a buying strike and refuses to buy any bonds at the government bond auction, then that means the government could default. But if the central bank can directly acquire government debt at the auction, then it can prevent a government default.

Yeah, the distinction certainly exists, just seems like much (or at least some) of it is optical rather than substantive. Primary dealers backstop the auctions, Fed backstops (so to speak) primary dealers as needed?

And I suppose you could also say that as long as the Fed promises to buy in large quantity in the secondary market, then primary dealers can buy whatever size is necessary to complete the auction since they know they always have an outlet.

" It flows out of the government's account at the Bank of Canada and into the accounts that private banks maintain with the central bank."

Suppose it didn't. Suppose it flows into public holdings of Bank of Canada currency instead (which pays 0% interest. Then we agree we get a different result.

But (you quite reasonably ask), why would it flow into currency instead? Doesn't the Canadian public already hold as much currency as they want, given NGDP? Yes, I reply. But if the Bank of Canada raised the (implied) NGDP target at the same time (i.e. temporarily raised the explicit inflation target), and raised it by a big enough amount (approx 20 times $20 billion, given a 5% currency/NGDP ratio), then it would flow into currency instead.

The BoC needn't pay the 0.5% to banks. It's really not that hard to see why some people think it is effective. You can blow the nominal net wealth(outside money) of a country's private sector to infinity with helicopter money at no cost to the government.

But if in our example the Bank if allowed to reduce rates then why not have it cut to 0% at the outset, then have Trudeau issue t-bills to the public at 0% in order to finance the $20 billion cheque mailing. We still get to the same ending point as a $20 billion helicopter drop with the banks being paid 0%. No?

I agree with your assessment; helicopter money does not accomplish anything.

The buildup of the government's balance is interesting. It's issuing bonds, but where is the private sector getting the cash from (since settlement balances at the BoC stick near zero)? (The BoC is buying some bonds directly, as you note, which helps for some of the buildup.) My guess is that the government is just lending it back to the banks. I was never able to find the stats on the size of the MoF's lending programme (I forget the name). If that guess is correct, the government is issuing bonds in order to allow it to lend the money to banks. I am sure some brainiac got a promotion for that brilliant piece of policy wizardry.

"The BoC is buying some bonds directly, as you note, which helps for some of the buildup."

As far as I know, direct buying from the government by the BoC is responsible for *all* of the buildup.

But if it was using the private sector to build its balances, I agree with you. If Trudeau asked banks to transfer all $20 billion in funds raised via bond issuance to the government account at the BoC, a huge deficit in settlement balances would appear. Overnight rates would spike. The only way to keep rates on target would be to auction cash to the banks (ie. lend to them).

Honestly, it's so pathetically obvious why you're wrong it pains me to have to type this...

If the $20 billion comes in the first place from the sale of bonds on the open market, this DECREASES THE MONEY SUPPLY BY $20 BILLION. Then when you increase the money supply you've accomplished NOTHING.

Whereas if the $20 billion comes in the first place from money printing, YOU ACTUALLY INCREASE THE MONEY SUPPLY.

No. Because the $20 billion that is spent as Trudeau draws down his PLMP balances at the BoC are not 'money'; they are exactly the same as a t-bill.

Sure, the first $4 or so million might be considered 'money.' But after that, the marginal liquidity services provided by BoC clearing balances falls to zero. BoC balances and t-bills are exactly similar.

So in both scenarios, the supply of debt has increased by $20 billion.

Good question. And then there's 0) When the government first publicly announces a heli money plan... because behaviour will start to change even before the plan goes into action. People are forward-looking.

Yes, you are correct about event 0) which comes when the helicopter program becomes probable. As I considered that observation further, I can't help but think that When's 6 and 7 should be moved up in the time sequence. Foreign currency traders must be a very forward looking bunch; their very survival depends upon correct forward-looking decisions.

There is a major difference between your description of H-money and that described by Bernanke in re: Japan. BB's idea is for the bonds issued to be zero-coupon perpetuals. Such bonds are unmarketable, so there is no question but that the BOJ will hold them indefinitely. Any potentially marketable bond carries the risk that the central bank will ultimately sell the bonds into the market, making the free money not free at all.

Good point. But even if we use BB's zero-coupon perpetual idea, I still don't see any difference between Trudeau financing his check mailing program via the regular route (t-bills sold to the public) or by lodging zero-coupon perpetuals with the Bank of Canada. Assume the latter. As the government spends down its account at the Bank of Canada, the recipients of those balances will now have to be paid interest--so its exactly as if the government had issued t-bills and gone the traditional route.

Under the current US bond buying program, banks have increased reserves, but they don't show up on my bank account balance...whereas check in the mail from gov't to me does. Isn't this a big difference as far as how much money I will spend?

A challenge to the status quo: the federal government is not dependent on bond buyers for funding and can use its fiscal capacity up to the limit of available resources. It is not limited by budget balances or debt-to-GDP ratios. If we had a progressive government, why support corporate welfare when the middlemen can be eliminated and as a bonus the fiscal myths can be shattered?

Bill Mitchell is a Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at the University of Newcastle, NSW, Australia.

"OMF simply means that in some form or another, the treasury arm of government tells the central bank it wants to spend a particular amount and the latter then ensures those funds are available for use in the government’s bank account.

Various accounting arrangements might accompany that action. For example, the treasury might sell some government bonds to the central bank to match the value of the funds that are placed in the treasury’s bank account. None of these accounting arrangements should cloud the fact that central banks can create money out of thin air.

Why go through all the hoopla of creating elaborate corporate welfare structures – like issuing government bonds to private sector traders – when the central bank can just create funds out of thin air?***OMF would be an incredibly efficient way to operationalise government spending. An instruction would be sent to the central bank from the treasury to transfer some funds out of its account at the central bank into an account in the private sector, which is held by the recipient of the spending.

***I would generalise that and say that what is happening in Britain and the US (with Bernie Sanders) now represents a real chance on the left to re-define the progressive narrative and firmly take it out of the neo-liberal framing that has trapped the debate for the last few decades and compromised successive governments.

***

The future is for a progressive force to articulate a plan that places full employment, equity, inclusion and environmental sustainability at the forefront and disabuses the public of the fiscal myths that it has been indoctrinated with by the right-wing think tanks, media and politicians (including New Labourites)."

Overt Monetary Financing would flush out the ideological disdain for fiscal policy

http://bilbo.economicoutlook.net/blog/?p=34071

"So it is true that paying interest on excess reserves is not fundamentally different to the government issuing debt to the non-government from the perspective that the income flows to the non-government sector are similar in each case.

It is also true that the central bank can influence the interest payments that are forthcoming under either scheme. Ultimately, the central bank can maintain (as in the Japanese case) zero or even negative interest rates if it wanted to on the excess reserves and on outstanding bond yields.

But so what? This doesn’t effect the degree of stimulus that is forthcoming from the government deficit increase.

It also imposes no additional or less inflation risk arising from the government deficit increase.

And, it doesn’t alter the quantum of net financial assets in the non-government sector. Only the portfolio composition is changed.

Where the difference lies is in public perception. There is no increase in public debt for the rabid financial commentators to beat up into a frenzy and push out predictions of insolvency.

They would turn their attention to the inflation risk – but then that would be shown to be ridiculous after just a few quarters.

So there are major political advantages in using OMF.

Further, it would force the non-government sector to innovate their own low-risk financial asset to be used as the benchmark for assessing risk. The days of corporate welfare in the form of guaranteed risk-free annuities would be over. They would still have risk-free bank reserves but not a stock of government bonds to soothe their uncertainty.***

Monetary policy is really such a blunt and ineffective tool that it should be rendered redundant. The mainstream have never provided a convincing case that manipulating interest rates is somehow the preferable and effective option for stabilising the spending cycle.

The GFC experience would suggest otherwise. All the monetary policy gymnastics have had very little impact.

It would be much better to set the overnight rate at zero and leave it there and allow the longer term rates (which are impacted by inflation risk) settle as low as possible.

Then, manage the spending cycle with fiscal initiatives that can be targetted, adjusted fairly quickly and which have direct impacts.

The “heavy price” the Voxeu authors fear would be nothing more than exposing that the emphasis (reliance) on monetary policy is just an ideological stunt to allow the neo-liberals to push fiscal policy into the undesirable basket.

OMF would bring this ideological crusade further out into the public arena and sink it once and for all."

His blog agrees with your facts, but not with your interpretation. You may be "underwhelmed" by helicopter money and agree that it "does not accomplish anything", but for Bill Mitchell OMF is a more efficient process that lifts the veil on government spending, shattering fiscal myths propagated by pundits and media. OMF is the key to transforming fiscal and monetary policies to primarily serve public purpose rather than the status quo of delivering inordinate benefits and the appearance of power to financial elites.

JP - There is nothing innovative about monetisation of fiscal deficits, which in effect happens as a matter of course everywhere when base money grows. There is still a difference between money financing deficits and bond financing - the significance of this distinction rests highly on legal and institutional structure. In Canada’s case it is not v relevant, although relevant enough for the central bank to be independent. Government bond issuance is regulated by market interest rate expectations - there is in fact market discipline and price signal to regulate issuance. CBs create money subject to inflation targets. The apparent interest rate equivalence in Canada of money and bond-finance is also somewhat coincidental - the Canadian central bank *could* pay a different rate on the majority of bank reserves than the government pays on bonds (as the Bank of Japan is doing). The IOR is a way to compensate/subsidise banks or manage demand for reserves - but there are other ways to do this. In the history of monetary policy, as you know, this is common. It is true that regulatory demand for government bonds can also be manipulated, but again, the intention and scope of this is usually very different.

To make explicit the distinction between money and bond finance, you need to look at a jurisdiction where the Treasury and central bank are completely divorced, in stark contrast to Canada - Greece. The Greek government can issue government bonds & bills, but cannot create money. It does indeed face a severe budget constraint and does not have the option of inflating away debt. Money and bonds are not equivalent.

However, as a policy innovation, HM designates something other than the monetisation of deficits - it involves (1) either transfers from the CB to the private sector, or (2) some attempt to shock beliefs about inflation (this is the 'permanence' debate). I don't want to dwell on (2) because I think any attempt to do so pre-supposes that the CB can actually raise demand. And if it can, it doesn't need to do (2). This is why (1) is key. Now, I have argued that (1) is close to *economically* equivalent in most jurisdictions to a tax cut, but institutionally it is poles apart. And the institutional division of labour in many parts of the world is profoundly important - which is why we have independent central banks. Central banks use the supply of base money to target inflation. Their current tools are ineffective. Give them simple and more effective tools. Now, arguing that a transfer from a CB to household bank account is *really* no different to a tax cut, completely misses the point - it is done by the central bank (using a non-market-disciplined supply of finance).

It should also be pointed out that central banks have considerable decision-making advantages over treasuries, which is another reason why counter-cyclical demand-management has been delegated to them: they can make quick decisions that have immediate effects, they can similarly calibrate or reverse these decisions almost instantaneously. In summary, the institutional division of labour matters, so does control of the money supply. So the real question to ask of helicopter drops (type 1) is: would they make monetary policy more effective?

Your point about central bank decision-making advantages is well-taken. One is a technocratic process, the other political. That's a categorical difference.

Apart from the technocratic vs political divide, my understanding of helicopter money is that for it to have unique properties (i.e. be different from regular spending), the Bank of Canada needs to pay less than the market clearing interest rate. If both the overnight rate and the rate on government bills are at 0.5% (as they are now), then the BoC should be paying 0%. Otherwise helicopter money is just like regular bond-financed spending, right? This is the point that Bernanke was making:

It is true that the Canadian central bank *could* pay a different rate on the majority of bank reserves than the government pays on bonds. After all, the Bank of Canada is a government enforced monopoly and the Royal Bank or TD Bank simply cannot choose to walk away--refusal to accept 0% liabilities (say by starting an alternative clearing house) would be breaking the law. But surely the government could extend it's ability to force uptake to regular issuance of debt, ie. require Royal and TD to take up a portion of each 0% government debt issue auction, even as the BoC is paying 0.5% on deposits.

Forcing participation at 0% debt auctions would be a big change to existing tradition. But so would any decision to cease paying interest on deposits. In Canada, we've been paying interest on deposits since the mid 1990s. Does the uniqueness of helicopter money come down to the fact that the amount of pushback involved in implementing a 0% deposit rate is less than the pushback involved in forced government 0% debt auctions? If so, that's not a categorical difference, more a difference of a degree.

In sum, apart from the technocratic/political divide, I still have problems seeing a difference between Trudeau financing a mass check mailing via the regular route or via the Bank of Canada. We can always synthesize helicopter money with a some sort of equivalent form of government spending that does not involve the central bank, at least in theory. No?

JP - Broadly, I think we agree. *In the case of Canada* there is not much *economic* difference, currently between a bond-financed check from the government and a perpetual, zero interest loan from the CB - apart from the decision-making advantages/differences that we agree on, and which I think are extremely important. Not least because in the central bank's case policy is consistent through time and does not change with the electoral cycle or political colour of the government. Also, you have not really addressed the point that, absent the power to helicopter drop, we may lose a major counter-cyclical part of macro policy - monetary policy.

I would also, stress that there is a coherent division of labour between the fiscal and monetary authorities which should persist. The existence of market discipline on government body issuance is important. So is the ability of CBs to credibly hit inflation targets. The tools CBs have to deal with excess reserves (bond issuance, required reserves, tiered reserves, IORs) are all necessary constituents of monetary policy - helicopter drops or not. By contrast, forcing banks to hold government bonds in order to distort funding costs *undermines* the function of markets. The government bond market should not be organised to make fiscal policy and monetary policy equivalent. In extremis, the government could decree that bonds are money!

Finally, Canadian institutional structure is at one end of the spectrum - at least currently. This would change if there was disagreement between the CB and government (do Canadian institutions ever disagree?!). At the other extreme, there is the Eurozone. And I reiterate, consider Greece - money financing and bond financing are poles apart.

"The evidence is that while inflation targeting does not generate significant improvements in the real performance of the economy, the ideology that accompanies inflation targeting does damage the real economy because it embraces a bias towards passive fiscal policy which in our view locks in persistently high levels of labour underutilisation.

Disinflationary monetary policy and tight fiscal policy can bring inflation down and stabilise it but it does so at the expense of creating and maintaining a buffer stock of unemployment. The policy approach is seemingly incapable of achieving both price stability and full employment. I constantly write about these failings.

An examination of the research literature suggests that inflation targeting has not been effective in achieving its aims. This is despite the constant claims by the proponents to the contrary. Only a minority of the research literature supports the contrary view.

The most comprehensive and rigorous work on the impact of inflation targeting is the 2003 study by Ball and Sheridan who aimed to measure the effects of inflation targeting on macroeconomic performance in 20 OECD economies, of which seven adopted inflation targeting in the 1990s.

They used special econometric techniques (which are widely accepted) to compare nations that had adopted targeting to those that had not. Overall, Ball and Sheridan found that inflation targeting does not deliver superior economic outcomes (mean inflation, inflation variability, real output variability, long-term interest rates)."

At close to zero rates, the effects of further reductions are ambiguous at best, and when liquidity is already plentiful QE transfers net income to the CB. In summary, absent heli drops CBs may well be unable to meet CPI targets. In Europe there is a high probability this is already the case. Likewise Japan. Heli money therefore preserves/saves monetary policy.

JP - I hope I have also made it clear that there is a profound difference between monetary and bond finance. The coincidence of rates currently in Canada renders a superficial equivalence. There are very clearly circumstances where this does not hold - for example if the Bank of Canada believed that the government's fiscal policy undermined its inflation mandate and it refused to stand behind it. Conversely, it is very easy to see a situation where the CB wants to do a hell drop to meet its inflation target and the government does not want to engage in fiscal stimulus. The institutional distinction is critical, as is the difference between money and bond finance. Greece, as I alluded to above, is the live counterfactual.

Correction: I rather glibly asserted that the Bank of Canada is independent - I am not familiar with its precise legal and political status. This too, highlights the fact that relative institutional power is relevant to the bond/money distinction.

Where the article is useful is in getting to the nub of the issue of HM. Many proponents such as Buiter, Skidelsky Turner , require that somehow debt between gvt and CB is not repayable and therefore disappears.

He says that a new issue of gilts which is bought directly by the UK government "increases the government's deficit but not the national debt [sic ] since a loan by the central bank to the government is not intended to be repaid".

This goes back to my favorite question viz "what does give mean? " . If the BoE "lends" money to the government which is not intended to be repaid then they have not "lent" it they have "given" it. And if they've given it then they have a big hole in their balance sheet which the government would have to fix. I am pretty sure that the IMF statistics boys would see through this, having done their basic accounting courses.

So can you fool some of the people some of the time with HM ? Yes, but in this case not the people who matter unfortunately.

The government does not "have to fix it", because the hole in the balance sheet does not have ths same meaning as for a currency user:

".....the European Central Bank published a research paper titled "Profit distribution and loss coverage rules for central banks."***

In talking about profitability of a central bank the ECB says in its paper that it is not necessary for a central bank to make money, as this is not a useful measure of the efficacy of the bank. While noting that profitability may be useful for a central bank's credibility, the paper makes the critical point that losses made by a central bank do not lead to the bank needing to be recapitalized, or the bank becoming insolvent.

The ECB makes this point in a footnote on page 10:

"Central banks are protected from insolvency due to their ability to create money and can therefore operate with negative equity."

Central banks cannot run out of money because they are the ones that create the money. And you cannot run out of something you can create yourself."

Btw, I loved your piece on the history of the relationship between the BoE and HMT. So the BoE has been lending privately to HMT! Mind you, it clearly did have the intention to pay it back. Although the EU had to remind them!

Demand higher interest rates and a cease to bond buying by the BOC. The Bank of Canada ACt preamble states that the BOC is to protect and control the monetary unit of the nation (C$), which is loosing value and purchasing power as it sinks into the abyss, all because of manipulated low interest rates to save the rich and shaft the rest. Demand free market determination of interest rates and an end to crony capitalism or more accurately know as Socialism for the rich.